A Practitioner’s Guide to Defaults, Extensions, Discounted Payoffs and Getting Value Out of a Broken Loan
Julian R. Sterling
Four Excel workbooks. Every figure the book prints is reproduced here by a live formula,
and every workbook ends with a checks sheet listing the book’s figure beside what the
workbook computes. They are free. Nothing is gated behind a sign-up, and no email address is
asked for.
Everything described below is inside it, with the read-me.
Chapters 3 to 8 · the whole decision
Harbour Quay: four ways out, priced against each other
The whole book on four sheets. One broken loan — an office bought at a
4.50 per cent yield and refinanced into a 6.65 per cent market — and
four ways out of it, each discounted to today over its own timetable so that the four are
actually comparable. That comparison is what the book exists to make, and it is
the one a credit committee is almost never shown, because the four options arrive on four
different pages with four different horizons.
Go to sheet 3 and read the last line: 58.7 cents, the price at
which a discounted payoff exactly matches what enforcement would return. Then go back to
Assumptions and raise the forced-sale discount from 18 to 30 per cent. The indifference
point falls to 49.6 cents, and nothing about the building, the borrower or the loan has
changed.
That sensitivity is the negotiation. Whoever knows the number sets the range.
Harbour_Quay_The_Four_Options.xlsx · XLSX · 15 KB
Chapters 5 and 6
Enforcement, which every other option is measured against
Enforcement is the alternative every other option is priced against, and it is the one most
often estimated rather than computed. Four separate things destroy the value — the
forced-sale discount, the delay, the transaction costs and the cost of carrying the asset
— and sheet 2 shows each of them in euros and in cents on the euro of loan,
ranked. On the base case the largest is not the one people assume.
Sheet 3 is a two-way grid over the discount and the delay, in recovery and again in
indifference point: find your own view in the grid rather than arguing about a base case.
Sheet 4 runs the identical loan through six asset classes —
residential recovers 102.5 per cent, a shopping centre 31.3 —
and prices a receiver against a share pledge, which is worth nineteen points.
At the bottom of sheet 4: what waiting a year costs. Even on an improving market it
loses money, and the break-even yield compression is 73 basis points a year.
The_Enforcement_Model.xlsx · XLSX · 13 KB
Chapters 9 to 12
The extension, which looks best on paper
Three years of cash flow with interest capped at the income the building actually earns,
the shortfall added to the balance rather than quietly forgiven, capex funded by
the sponsor before any lender money, and an exit capped at the outstanding balance. The covenants
are re-tested each year, because an extension that breaches in year two has not been thought
through.
Sheet 4 is the sheet that matters: a grid over year-3 income and exit yield, against the
recovery on the payoff that is actually on the table. An extension that only works in one corner
of that grid is not a plan, it is a hope with a term sheet attached.
Also inside, and left out of most workout analyses entirely: the swap mark to market, and what
the sponsor guarantee is actually worth once the solvency discount, the time discount
and the years it takes to collect are applied. On this file that is
4.8 points of recovery, against a headline cap that suggests far more.
The_Extension_Model.xlsx · XLSX · 15 KB
Appendix A · the committee paper
The eighty questions, and the switching values
The eighty diligence questions as a live checklist — the same eighty, generated from
the same source as the appendix, so the book and the workbook cannot drift apart. There are
columns for the answer, the source document, the owner and the date, and the
status column marks anything answered without a source as unsourced. A question whose
answer is “the borrower says” is not answered.
Then the one-page decision record, and the committee paper’s switching values: the level
of each input at which the recommendation changes. Five lines, and the committee knows exactly
how wrong it can afford to be.
Do not work through the eighty in order. Start with sections three and four — cash and
income — because those can be answered from documents rather than from the borrower.
The reason a workout committee argues in circles is that the four options are never presented on
the same basis. Enforcement returns cash in two years; an extension returns it in three or four;
a discounted payoff returns it next month. Comparing a recovery percentage across those three
timetables is comparing nothing at all.
Discounted to today over its own timetable, the same loan gives
enforcement 46.42 (56.3 per cent), the extension 81.75 (99.1), and a discounted
payoff at the price on the table 56.89 (69.0). The extension wins here — and the
grid on sheet 4 of the extension model shows exactly how narrow the corner is in which it
keeps winning.
The line that changes a negotiation
58.7 cents. Below it a discounted payoff is worse than enforcing; above it,
better. A borrower offering 55 is offering less than the lender’s own alternative, and a
lender demanding 70 is asking for more than its alternative supports. Neither side normally knows
the number, so the range gets set by whoever is more confident — which is not the same thing
as whoever is right.
It also moves. Ten cents on the forced-sale discount alone. That is why the workbook makes the
discount an input rather than a house assumption, and why the honest way to take this into a
meeting is with the grid rather than the point.
One thing the checks sheet caught
The extension model originally forgave the unpaid interest instead of adding it to the
balance, and the checks sheet caught it: 79.86 against the 81.75 the book states. Both the book
and the workbooks now capitalise the shortfall, which is what the loan documents would do. The
recovery moved from 96.8 per cent to 99.1, and the error had been in the direction that
flatters the lender — which is the direction errors in workout models usually run.
Conventions used throughout
Blue on a pale fill
an input — you may edit these
Black text
a formula — do not overtype these
Yellow fill
the assumptions that carry the answer
Checks sheet
fifty-five figures, each beside the figure the book prints
Amounts are in millions of euros. Harbour Quay is fictional, and deliberately ordinary
rather than extreme: it is the commonest broken loan there is. Fifty-five figures are
tested across the four workbooks and all fifty-five reproduce, each to the precision the
book prints at — a figure printed to two decimals is checked to 0.005. The rule behind those
sheets is the reason to trust them: if a check fails, the model is wrong until proven
otherwise, not the book.
Opening the files
The workbooks open in Microsoft Excel, LibreOffice Calc, Google Sheets and Numbers. They use
no macros and no add-ins, so nothing needs to be enabled or trusted. If your spreadsheet asks
to update links on opening, decline — there are none.
Also by Julian R. Sterling
The other books with companion files. The full list of titles is on the
author page.
Closing the DealTwo defensible bridges 20.70 million apart, a peg worth 7.00 million, and the six choices that remove 6.60 of a 12.00 earn-out.
CMBS and CRE CLOsWhere the loss actually lands, from appraisal reduction to realised severity, and what the B-piece is really being paid for.
How to Read a Commercial LeaseThe three refinements chapter 19 names and never performs, and the renewal rate below which the mark-to-market is worth nothing.
How to Read a Credit AgreementWhere the default actually comes from, the cure that costs 5.5 times the other, and the capacity nobody adds up.
How to Read a Real Estate Loan AgreementThe cure ratio in closed form, the four-point window in which the cheap cure works, and the cure sized to the wrong threshold.
Office Real EstateA six per cent yield that returns 3.2 per cent once the re-letting cycle is paid for, and the headline-to-net-effective rent arithmetic.
Private Equity Real EstateBoth worked waterfalls to the dollar, the two capital stacks, and the arithmetic of the promote made changeable.
Private Markets PerformanceThirty-one of the thirty-three figures chapter 19 publishes reproduce exactly — and the two that do not are named rather than quietly adopted.
Raising a Real Estate FundThe chapter 17 funnel run on a calendar — when the first close actually lands, and why more travel does not help.
Real Estate FinanceFour people look at one building and reach four numbers; the lender is whole only above 105,109,489, twelve per cent below today’s value rather than forty.
Real Estate Financial ModelingProperty, development and fund models built line by line, and the modelling test worked end to end.
Real Estate Fund ManagementThe waterfall of 6.11, the build-to-core of 8.7 and the proceeds gap, reproduced as live formulas rather than asserted.
REIT Analysis and ValuationFFO of 532.0, AFFO of 381.0, net asset value and dividend safety — every figure a formula you can change.
Retail Real EstateThe occupancy cost of every unit in a centre, the sixteen per cent of the rent roll no tenant can sustain, and the right-size-convert-or-hold decision priced.
Sale and LeasebackA €179.5 million transaction end to end, with rent cover measured on the entity that actually signs the lease.
Self-Storage Real EstateThe cohort engine behind a 590-unit store, and the rate increase on existing customers priced against the move-outs it causes.
The Fund Finance ProfessionalChapter 8 builds the reported-to-eligible NAV bridge; chapter 9 computes every ratio without it. Two points at every state — and what a subscription line does to the IRR.
The Growth Equity InvestorWhat a pro rata cheque really costs, and the band where defending your ownership loses money.
The Private Credit InvestorThe two coverage ratios are not measured on the same thing: the erosion is 47.7 per cent, not the 28.7 the headline implies.
The Private Equity Fund Controller PlaybookThe book defines IRR, DPI, RVPI and TVPI, tells you to update them at the exit, and prints not one value. Computed: a 1.833× deal inside a fund at 0.892 TVPI.
The Venture Capital AssociateWhat defending a position costs, and how many companies a reserve pool actually defends.
Financial Risk ManagementA fund inside every limit that cannot meet a redemption — and the number that decides it is the one with no currency attached.
Business ValuationThree advisers land 26.8 per cent apart on one company, and the whole gap turns out to be 1.96 points of perpetual growth.
Quantitative FinanceThree models agree to a quarter of one per cent about a number that one unobservable input moves a hundred and three times as much.
Asset ManagementFour people quote four returns for one mandate, all correct and 2.7017 points apart — forty-eight times the manager’s net skill.
Alternative InvestmentsA manager reports 13.29 per cent and the endowment earns 6.26 — both correct, and only a third of the advertised advantage arrives.
Credit AnalysisFour defensible EBITDAs on one borrower give leverage from 3.19x to 6.47x — and the add-back argument is fifty times the covenant headroom.
Venture CapitalOne company out of twenty-eight returns 56.7 per cent of the fund, and half the capital goes in after the decision — at half the return.
Machine Learning for FinanceFive people quote the accuracy of one credit model, all five are right, and the number that decides how much money it makes is none of them.
Commercial Real Estate InvestingThe equity earned 8.6647 per cent and the investor received exactly 8.0000 — the preferred return, and nothing above it.
Mergers and AcquisitionsThe board paper says the deal creates 13,436,667 of value. The arithmetic says it destroys 17,530,855. Nobody is lying.
DerivativesThe treasury report says the hedge cost 1,233,698. That is the interest differential, not a cost.
Treasury ManagementFive cash balances for one company, all correct and 145,600,000 apart — and the revolver that is two-thirds of the liquidity leaves at a revenue fall of 8.4127 per cent.
Financial Planning and AnalysisRevenue 3.0190 per cent above budget and operating profit 16.3209 per cent below it, in the same quarter, with every figure correctly stated.
Energy TradingA position report that is 91.7031 per cent hedged and correctly computed, on a book that is short 2,542,000 MWh — and a margin call of 198,400,000 the next morning.
Construction Cost ControlA contract sum of 26,301,102 became a final account of 29,153,363 on the building that was drawn — and 85.8 per cent of what was lost was knowable on the day it was signed.
Pricing StrategyA list price of 148.00, a pocket price of 112.51, and the nine deductions in between — with what one point of price is actually worth.